One of the best equity funds over the past decade, Fairholme (FAIRX), is down more than 25 percent this year.
Most of this weak performance comes down to the fund having an extremely high percentage of its assets in financial stocks. The size of Fairholme's exposure to that sector has already received its fair share of coverage.
Well, as it turns out, they've not backed off that sector one bit. In fact, the fund recently disclosed it now has roughly a 90% (previously it was more like 75%) of its assets in financial stocks.
With the exception of Sears (SHLD), just about every non-financial stock in the fund was sold during the last reported quarter. A small amount of Vodafone (VOD) was purchased but it had less than 1/10 of a percent impact on the portfolio.
The top five holdings make up more than 50% of the portfolio. As always, much like Berkshire Hathaway (BRKa), the portfolio is a very concentrated one.
It's hard for me to imagine having more than 10-15% exposure to financials and even then it's the highest quality stuff like Wells Fargo (WFC), U.S. Bancorp (USB), and American Express (AXP).
Essentially, I keep a small percentage exposure to banks and other financial stocks because of the hard to quantify systemic risks. Much of that risk comes down to credit derivatives of various kinds. As long as those side bets can be made with too little oversight and weak disclosure the financial system will remain less robust than it should be.
From the 2002 Berkshire Hathaway shareholder letter:
...derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts. When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don’t understand how much risk the institution is running.
Even the best run bank (and, of course, the global economy) can be hurt badly when confidence in the system goes south.
Fairholme deserves some credit for being bold. Having said that, even if it worked out well in the long run, I'd have a tough time handling risk management with 90% exposure to financials.
Long BRKb, WFC, USB, and AXP
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